Based on the average profit margin of 7,25% and that the procurement costs are 60% of the production cost, we have following P/L-account:
| Before | After | |
| Sales | € 1200 | € 1200 |
| Procurement | €, 600 | € 594 |
| Production | € 400 | € 400 |
| SG&A | € 113 | € 113 |
Margin |
€ 87 |
€ 93 |
|
% Profit |
7,25% | 7,75% |
| Leverage | 1,069 |
There are two columns. Before cost reduction and after cost reduction. Let’s assume that the procurement costs are reduced with 1%, and that sales and all other costs remain on the same level. The profit margin jumps to 7,75%. This is an increase of 6,9% compared with the former profit margin. We speak in general of factor 6, although we could say that it is almost 7.
Of course your reality of business is more complex, but sometimes a simple model leads to new insights.
In reality we assess other soft and hard benefits of a better spend control:
• Enhanced factor productivity, which decreases the production costs
• Lower administrative transaction costs, which decreases SG&A (costs of sales, general and administration)
• Better fulfillment of the sales orders, which lifts your turn-over.
